U.S. presses lenders to heed clients’ ability to pay

Banking regulators unveiled formal guidelines Friday to stop abuses in the market for high-cost mortgages. Rising defaults have hammered lending firms and brought turmoil to Wall Street.

A theme of the guidelines is that lenders must pay greater heed to borrowers’ ability to repay mortgages, especially as payments increase during scheduled adjustments.

The guidelines, which closely follow a proposal unveiled in March, apply to banks, thrifts and credit unions, many of which have already raised their standards. The new guidelines do not apply to independent, nonbank lenders that played a major role in selling the high-cost mortgages. They were released by the Federal Reserve, the Office of the Comptroller of the Currency and other U.S. agencies.

“While I congratulate the regulators for what they have done today, let me be clear: We still have a considerable distance to travel,” said Sen. Christopher J. Dodd (D-Conn.), chairman of the Senate Banking Committee.

Under the guidelines, which are advisory, lenders would be expected to:

* Fully consider a borrower’s ability to repay a loan after it rises to a fully indexed rate that might cost hundreds of dollars more a month than the initial, “teaser” rate. In a change from the original proposal, regulators Friday said the assessment should also include the costs of taxes and insurance.

* Provide consumers with clear-cut disclosures on the prospects for “payment shock” when their loans are adjusted upward. Clear disclosures are also expected for prepayment penalties that can make it extremely expensive for a borrower to pay off a loan early.

* Verify a borrower’s income in most cases, relying on documents rather than verbal representations. It had become increasingly common for lenders to approve loans without strict documentation, and many of these mortgages are now failing.

* Allow borrowers to refinance loans without incurring a prepayment penalty at least 60 days before the initial reset date of the loan payment.

With housing prices falling in many parts of the country, beleaguered borrowers have been unable to refinance their way out of trouble, leading to a surge in mortgage defaults. Many of the troubled mortgages have adjustable interest rates, designed to lure in customers with cheap teaser rates that later jump.

In a statement Friday, Federal Reserve Gov. Randall S. Kroszner said the guidelines were designed to ensure that borrowers could afford their mortgages after the low-cost period expired. “It’s only good business sense for the lenders, and it’s the right thing to do for the borrowers’ sake,” he said.

Members of Congress and consumer advocates have criticized U.S. bank regulators for lax oversight as problems emerged in the industry of marketing high-cost, sub-prime loans to borrowers with weak credit.

Nonetheless, lenders cautioned that regulatory overreaction would have a chilling effect that could make credit unavailable to deserving borrowers.

A representative of the mortgage-banking industry suggested Friday that regulators might have gone overboard with the latest standards. “This is a strong statement that will help curb abuses but will likely also constrain consumer credit choices,” John M. Robbins, chairman of the Mortgage Bankers Assn., said in a statement.

Robbins also urged Congress not to move forward with legislation mandating stricter lending standards but rather to emphasize “transparency and accountability” during the mortgage transaction.

A Countrywide Financial Corp. spokesman told The Times in May that the Calabasas-based mortgage giant was modifying its systems to restrict hybrid adjustable-rate mortgages -- loans with low fixed interest rates for the first two or three years -- to borrowers with enough income to handle the eventual higher rate. A Countrywide executive had told Congress in March that 60% of those who previously qualified for the hybrid ARMs would not qualify under the new guidelines.

In March, Santa Monica-based Fremont General Corp., whose Fremont Investment & Loan had been a top five sub-prime lender, was pressured into shutting down sub-prime originations by the Federal Deposit Insurance Corp., which accused it of making loans that were likely to end in foreclosure. Last month, Fremont brought in a new team of investors and managers to run the company along the lines of a traditional bank.

Howard Glaser, a mortgage industry analyst and former U.S. housing official, said regulators fended off efforts by lobbyists to water down the guidelines. Following up their initial proposal within three months amounted to “light speed” for the regulators, he added, indicating the pressure they faced to respond to the problems.

“Our initial read is that the regulators stuck to their guns,” Glaser said Friday.

jonathan.peterson@latimes .com

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Times staff writer E. Scott Reckard in Orange County contributed to this report.